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August 22, 2005

The Economist on the Budget Deficit

The Economist reminds me of how good it can be in a short space, as it pities the poor fools who write for the Wall Street Journal editorial page:

The budget deficit | Cocktail-bar calculations | Economist.com: [T]he latest projections from the legislature's non-partisan budget-watcher have excited a few of Mr Laffer's fans. The federal budget deficit, the CBO reckons, will narrow to $331 billion this fiscal year (which ends on September 30th), from $412 billion the year before. Tom DeLay, the Republican majority leader in the House of Representatives, was quick to offer a Laffer-like explanation: "Lower taxes and spending discipline spur economic growth, which in turn cuts the deficit," he opined.

In fact, spending discipline is still rather lacking. Government outlays will increase by $181 billion (or 8%) this year, a figure that does not include the cost of the pork-stuffed highway bill, signed by the president on August 10th....

Is Mr DeLay right to attribute any of these gains to the seductive curves of supply-side economics? In December, Gregory Mankiw, who used to be chairman of Mr Bush's Council of Economic Advisers, and Matthew Weinzierl, a colleague at Harvard University, published a "back-of-the-envelope guide" to tax rates and revenues.... [B]y their reckoning cutting taxes on labour would generate enough growth to recoup about 17 cents on the dollar, and a tax cut on capital could pay for more than half of itself. The government would take a thinner slice of a bigger pie.

Left out of these calculations is any guide to what happens when taxes are cut but spending is not. The budget deficits that ensue will tend to "crowd out" investment, slowing growth. The CBO calculates that every extra dollar of federal borrowing reduces investment in the economy by 36 cents.

The White House['s]... latest forecast... assumes (absurdly) that Congress will not add a single dollar to its discretionary spending on anything except defence and homeland security from 2006 to 2010. It also leaves out of its projections any extra money for Iraq, Afghanistan or the war on terror...

The failure to take account of what happens "when taxes are cut but spending is not" makes Mankiw and Weinzierl a bad guide to the likely future effects of the Bush tax cuts.

Posted by DeLong at August 22, 2005 05:51 PM